Mid Week Bond Update

U.S. Retail Sales: Worth the Wait?

December retail sales in the U.S. disappointed; credit conditions in Asia ex Japan improved; U.S. Treasury term premium continued to drop

U.S. Retail Sales: Worth the Wait?

Retail sales figures for the key holiday shopping month of December were held back due to the partial U.S. government shutdown. When finally released, they took many by surprise – to the point of calling the accuracy of the data into question. One key example: non-store retailers, which includes online shopping, showed a -3.9% decline in December vs. November -- coming on top of a downward revision of November’s previously-released figures.

The shutdown itself, which began on December 22, could also have decreased purchases by the employees directly affected by said shutdown.

If the disappointing trends suggested by December release turns out to be more than a quirk due to the shutdown, that would help vindicate the Fed’s dovish turn, which appeared to have taken its cues from financial markets’ signals about weaker prospects for growth.

More insight into the Fed’s change of heart on rate policy is expected in the soon-to-be-released minutes of the January FOMC meeting.

Retail sales ended 2018 on a downbeat note

Chart courtesy of Western Asset. Source: Census Bureau, as of 31 Dec 18. * "Control" retail sales is total sales less vehicle dealers, service stations and building materials stores. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

On the rise:Asia (ex-Japan) credit

The Fed’s dovish stance may have been one component contributing to the improvement in the availability and cost of credit in Asia outside Japan, at least according to the Bloomberg Asia ex-Japan Financial Conditions Index. As markets adjusted to the change in stance by the U.S. central bank, increased certainty regarding the path of future rates may have boosted U.S. dollar borrowing.

Other positive factors closer to home for the region include China’s emphasis on improving overall lending conditions, which as of the end of January 2019 has resulted in total aggregate financing (i.e., credit) of some 4.64 trillion yuan ($685 billion), some 1.3 trillion yuan higher than expected.

Also reflecting the easier environment: spreads for Emerging Market (EM) U.S. dollar credit, which have fallen from their early January peak of 2.97% to 2.49% as of February 18, 2019—up from a recent low of 2.39% on February 8.

On the slide: U.S. Treasury Term Premium

The term premium – a measure of the relative value of a long-term bond vs. short-term equivalents1 -- for 10-year U. S. Treasuries continues its drift into negative territory. As of February 14, the term premium is negative 0.7% -- suggesting that markets expect the 10-year Treasury yield to decline further from their level of 2.63% as of February 19, 2019. The negative value reflects, among other factors, the expectation that the Fed will continue its dovish stance, at least in the near term. The publication of the minutes of the FOMC’s meeting at the end of January is expected to shed more light on the flavor of the forecast and is eagerly awaited as a result.

All data Source: Bloomberg as of February 20, 2018 unless otherwise specified.

1 Term premium represents the amount that an investor would receive as a result of holding the note for its term – ten years, for a 10-year U.S. Treasury note – vs. what he or she would receive by reinvesting the principal in a short-term equivalent, such as T-bills, for the same amount of time.

Definitions:

The Federal Open Market Committee (FOMC) is a policy-making body of the Federal Reserve System(Fed) responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The Bloomberg Asia ex Japan Financial Conditions Index tracks the overall level of financial stress in Asia (excluding Japan) money, bond, and equity markets to help assess the availability and cost of credit. The index also includes a proxy for capital flows into Asia, which are considered to be an indicator of financial conditions.

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